What's Behind Europe's Bank Bailouts
Critics have faulted European governments for not doing enough to ease the worsening financial and economic crisis in their own backyard, but officials have moved with lightning speed this week.
Beginning over the weekend, they have bailed out or taken over five financial institutions (BusinessWeek.com, 9/29/08), including two in Belgium (Fortis and Dexia), British mortgage lender Bradford & Bingley (BB.L), Germany's Hypo Real Estate (HRXG.DE), and the third-largest lender in Iceland, Glitnir bank. In addition, the Irish government stepped in on Sept. 30 to guarantee the deposits of savers at Irish banks, which are now a cause of anxiety because of the cooling of one of the world's hottest real estate booms.
Both the $16 billion partial nationalization of Fortis (FOR.BR) and the $9 billion Dexia (DEXI.BR) rescue involved multiple governments: the Benelux countries in the case of Fortis, and the French and Belgian governments, along with Belgian regions and private investors, for Dexia. While it's more than a little worrying to see bailouts spreading across Europe, it's encouraging that governments were able to cooperate and raise big sums to save cross-border institutions.
Stunned by Congress
These moves at least temporarily calmed the European stock markets and for a moment have made Europe look good in comparison with the U.S., where the rejection of the Bush Administration's $700 billion bailout plan for the financial system by the House of Representatives stunned watching Europeans. Speaking on a BBC program on Sept. 29, European Trade Commissioner Peter Mandelson said: "I feel they've taken leave of their senses," referring to Congress.
One of the criticisms of the euro zone financial architecture is that the European Central Bank does not have "lender of last resort" responsibility and a clear mandate to deal with troubled financial institutions. In the absence of such powers, governments have stepped in, but observers think that these events underline the urgency of giving the ECB the needed firepower to act decisively. "I believe this should be a signpost for the future," says Richard Portes, a professor of economics at London Business School. "They should waste no time in giving the ECB enhanced authority. In due course this could be one of the fortunate consequences of this [situation]."
But as the Dexia bailout on Sept. 30 underlined, brush fires are still licking around the flanks of the European banking system. The biggest casualty so far has been Fortis, a midsize bank that reached too far in swallowing about a third of Dutch bank ABN Amro, which was the subject of one of Europe's hardest-fought takeover battles, between Britain's Barclays (BCS) and a consortium led by Royal Bank of Scotland (RBS) that also included Fortis and Spain's Santander (STD). The RBS group eventually prevailed for a price of about $102 billion last year, as Barclays management declined to participate in an all-out bidding war.
Fortis paid about $34 billion for its share of the spoils, which included retail networks in Belgium and the Netherlands, as well as private banking units. Now those businesses are on the block for much less. On June 15, 2007—just 15 months ago—Fortis' then CEO, Jean-Paul Votron, told a Goldman Sachs (GS) investment conference that the ABN deal created "a top financial institution in Europe set for growth." How times change.
Pressure on Royal Bank of Scotland
RBS, which has seen its share price fall by 61.5% over the past year, also has gone quickly from winner to loser. Earlier this year, the bank was forced into raising $23 billion in a share-rights issue to shore up its capital base (BusinessWeek.com, 4/18/08). Even so, it remains under pressure and is considered one of the big British banks that could get into trouble if the credit crisis grows considerably worse.
If that were to happen, RBS might be able to seek help from Santander, which has long had close ties to the Edinburgh company and is the only bank involved in the ABN Amro deal to come out well. (Even Barclays, which escaped overpaying for ABN, has seen its stock pummeled.) Santander picked up ABN's highly rated Brazilian unit and is taking advantage of the crisis to beef up its presence in Britain. In July, it bought troubled mortgage lender Alliance & Leicester (BusinessWeek.com, 7/15/08). And on Sept. 29, as part of the government's nationalization of Bradford & Bingley's loan portfolio, Santander swooped in to nab the bank's 197-office branch network and $38 million in customer deposits. Both of these latest acquisitions will be bolted onto Abbey National, another British bank that Santander bought in 2004.
Another big British bank under fire is Lloyds TSB (LYG), which agreed on Sept. 17 to buy the largest British mortgage lender, HBOS (HBOS.L) in a deal valued at $21 billion. It looked like a fire-sale price at the time, but since then both banks' share prices have been under pressure from investors worried that Lloyds is taking on too much credit risk by assuming HBOS's 19% share of Britain's $426 billion mortgage market. Adding HBOS would bring Lloyds TSB's total mortgage book to $624 billion, or about 28% of the total market. Concerns over whether HBOS would be able to fund itself have now transferred to the conservatively managed Lloyds (BusinessWeek.com, 9/26/08).
Up to the Task?
On Sept. 29, analysts at banking specialist Keefe, Bruyette & Woods (KBW) put an "underperform" rating on Lloyds, citing "relatively weak capital, a large loan/deposit funding gap, and high concentration in UK residential and commercial property." Lloyds CEO Eric Daniels had earlier tried to buy failing British mortgage lender Northern Rock and may have thought he had done a sweet deal getting HBOS. The British government even helped grease the wheels of the HBOS deal by waiving competition rules that blocked an effort for years by Lloyds to buy Abbey National (before Santander bagged it). Now, with British house prices falling, the economy souring, and investors in a highly risk-averse frame of mind, Daniels may have wished he had stayed on the fence.
Prime Minister Gordon Brown went out of his way to claim credit for the rescue deal. Now he may have another chance to prove that his government and financial regulators are up to the task of managing the first severe economic downturn since Labour came to power in 1997. So far, says London Business School's Portes, the managers of the largest financial center outside of the U.S. look "out of their depth." Bank of England Governor Mervyn King, for instance, has kept tight reins on money in what may turn out to be a misguided effort to cool inflation and teach lax bank executives and speculators not to enter into actions that could constitute "moral hazard."
The Prime Minister, who as Chancellor ceaselessly took credit for Britain's economic success, has himself been noteworthy for his lack of bold, proactive moves to head off what some commentators think could turn into a nasty recession. But, at least today, the American authorities don't look any better.
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